Don’t Levy an Excise Tax on Charitable Giving

Americans have long prided themselves on maintaining a free and open society that encourages private initiative and a minimum of government interference in their lives.

Even when individual behavior is thought by the majority to be wasteful, self-destructive, or both, we are still reluctant to make it illegal.

What do we do instead? We tax products that cause harm, like tobacco, alcohol, and gas guzzlers. And some environmentalists have proposed a “carbon tax” to discourage emissions that scientists say cause climate change.

The goal of such an approach is to raise the cost of undesirable behavior, as a way to reduce or abolish it. Unfortunately, the Obama administration’s new proposal on the tax treatment of charitable giving seems to take that approach to some donors’ gifts — resulting not in a reduced incentive but instead a real economic deterrent for wealthy people who choose to share with others.

The tax deduction for charitable giving has been part of the tax code since its beginning. Liberals like it as a way to encourage giving, while conservatives believe that money voluntarily given to charity is not really the same as the income people save or use for their own benefit — and therefore should not be taxed.

There have, however, always been some limits on the amount that Americans could give to charity and deduct from their otherwise taxable income. For example, one is not allowed to deduct charitable gifts of cash to the extent that they exceed 50 percent of one’s adjusted gross income (or 30 percent in the case of securities and certain other appreciated property.) The theory behind this limit is that no one should be able to completely avoid supporting the federal treasury by giving all their income to charity.

Experienced fund raisers know that some wealthy donors regularly encounter the income limits and alter the amount and timing of their gifts as a result. Many have heard a donor say, “My accountant says not to give any more this year.”

Why? Because to give more would mean that they are paying taxes on money they gave to charity.

Voluntarily giving up money that could be spent on your own needs to help others is one thing. Giving money for the benefit of others and then paying a tax on those funds is quite another. That is precisely what the administration’s new tax proposals would do.

Under current tax law, a donor in a 35-percent bracket who gave $100,000 to charity would not have the $100,000 to spend or save — and would also receive a charitable deduction of that amount.

The new proposal offered by the White House would change that rule, allowing a donor to deduct the entire $100,000 but save only 28 percent, or $28,000 of the $35,000 in tax on the $100,000 that would otherwise be due. That means donors write a check for $100,000 to charity and then an additional check for $7,000 to the federal government. If the highest tax bracket returns to 39 percent, that check would be $11,000.

The proposal has the effect under current law of requiring $107,000 of income to make a $100,000 gift rather than $100,000 of income. To keep the after-tax, out-of-pocket cost of the gift at $100,000, the donor would have to reduce the gift to approximately $93,500. In that case $93,500 goes to charity instead of $100,000. The other $6,500 has to be held back to pay the new 7-percent tax on the $93,500. If the rate goes up to 39 percent, the gift would have to be reduced to about $90,000.

That is the economic argument behind the assertion that giving by high-income donors could easily drop under this proposal.

To be sure, this tax rate is not much of a change for wealthy taxpayers who take advantage of legitimate means to reduce their incomes to the point that they would otherwise pay little tax. They already pay the alternative minimum tax at a rate of 28 percent, which is in reality the maximum tax rate for many wealthy people.

Thus, the bulk of the impact of the tax increase on charitable gifts would fall on the wealthiest people who are already paying at the highest rates and not using other means to reduce their taxes. There is something wrong with this picture.

The effect of the administration’s proposal is to put charitable giving by the wealthy in the same category as gas-guzzling autos and carbon emissions. Only no one really believes the administration considers charitable giving by those most capable of engaging in this activity to be a bad thing that should be taxed. It appears to be just unintended “collateral damage” in the war against inefficient health care.

A tax applies to everyone. A tariff, or excise tax, on the other hand, applies only to those who engage in certain behavior. If we limit the benefits of charitable deductions, we are, in effect, placing a “tariff” on some of the most desired activity in our society.

If as a nation we decided we needed to raise more revenue to fix health care, so be it. Let’s step back, though, and reconsider how we do it. Limiting deductions for mortgage interest paid by the wealthy and charitable gifts in the same way may not be the best approach.

The mortgage deduction benefits only the taxpayer, while forgoing taxes on amounts donated to charity benefits society as a whole. Too much mortgage interest being freely deductible may have arguably helped create the mess we find ourselves in — excessive charitable giving almost certainly did not.

If we have to raise taxes, then, why not instead impose a “health-care-equity surcharge tax” of, say, 5 percent on people with incomes of $250,000 or more and give a credit for amounts already given to charity? That way a person with a $1.25-million income who does not make charitable gifts would pay another $50,000 in tax. If a person gave $50,000 or more to charity, he or she would be exempt from the tax. If the donor gave $25,000, he or she would pay an additional surcharge tax of $25,000.

Americans with incomes of more than $200,000 gave $82-billion in 2006, according to Giving USA, the annual yearbook on American philanthropy. That represents 46 percent of all the tax-deductible gifts to charities in the United States. The report says that amounts to just over 40 percent of the $199-billion given to charities by individuals that year. People with incomes of $500,000 or more accounted for 32 percent of total deductions and 30 percent of the total donated. Those are not insignificant amounts.

An alternative such as the 5-percent health-care-equity surcharge tax, or something similar, would, as the administration has promised, raise taxes on those with the highest incomes. It would, however, also result in the least generous among the “wealthy” paying first, while those who have traditionally been generous would receive credit for what they have already been willing to do on a voluntary basis.

This approach may offer a fairer solution and one more in keeping with the American ideals both John F. Kennedy and Ronald Reagan called on us to respect and preserve for future generations.

Robert F. Sharpe Jr. is president of the Sharpe Group, a fund-raising consulting company in Memphis.